There are a few things to consider when you are applying for your fix and flip loan. If you are a first-time borrower, this process might be a bit shocking to you and slightly challenging. Just remember, it is important to do your diligence ahead of time, especially if you are a first-time borrower, and this list will help you get started on what you should consider.
1. Understand Different Types of Lenders
Traditionally, the lender that you would work with to buy a property (whether owner-occupied or investment) would be a bulge bracket bank or well-known retail bank. This would include Wells Fargo, Chase, Huntington, 5/3, PNC, etc. Depending on where you go for a traditional loan some banks will simply act as the loan originator and pass the loan onto the secondary market. Others, usually the large banks, will sometimes hold the loan on their books. Generally, over 50% of traditional loans, that are qualified mortgages, are held by government entities like Fannie Mae and Freddie Mac that will guarantee loans on the secondary market.
Loans for fix and flip projects will come from very different lenders. Usually, these lenders are private lenders, will be much smaller and limited geographically. Rates, loan terms, underwriting guidelines, fees, time-to-close and documentation will be completely different. It is important to understand the difference and do your research on your options, based on your project and what is most important to you.
2. Important Underwriting Equations - ARV and LTC
ARV and LTC are both equations that you will hear often when talking to lenders. In our post about 3 Factors that Determine Your Rate, we discussed how the deal affects the interest rate you will get with a lender, and if you will even get a loan!
LTC - This is the loan-to-cost or the amount of the loan as a % of the projected costs for your fix and flip deal. This is important because it tells the lender how much of their money is going towards the actual cost to improve the property and how much is going to the underlying value.
ARV - This is the after repair value or the % of the anticipated value of the property after you do the work to get it fixed up. This number is also important because it tells the lender a few things about you and the deal. If the lender is familiar with the area they will know right away how much you can get for a property in that area with certain repairs. This will help the lender to understand how honest you are about your projections and how familiar you are with the area.
3. Needed Documentation to Apply
The lender is going to require a bunch of different documentation from you for the deal that they are going to be lending you money for. In our other article: 13 Documents That You May Need for A Fix & Flip Real Estate Loan we detail all of the things that you will need to have in order to give to the lender. Having a good checklist of all the documents that you will need will not only help to speed up the process of getting to a yes or no with the lender but may also increase your ability to work with that lender in the future when you are ready for your next project.
4. Factor in Origination Fees
When working with any hard money lender they will require or charge the consumer an origination fee (consumer = borrower). Origination fees vary from 1% - 4% depending on your experience, size of the deal, location, and risk. The origination fee is meant to be compensation for the lender when they are taking on certain risks with a borrower. You should make sure to account for the origination fee when underwriting your deals!
5. Understanding Loan Payment Terms
Depending on your experience and what the loan is going to be used for, you will get certain payment terms that can affect the health and success of your project. If you are expecting to use draws on the loan to pay your contractors or construction crew throughout the project you will need to find a lender willing to give you a loan with a balloon payment (after-sale or refinance). Depending on the draw schedule or if the loan is all upfront can seriously impact the success of your project and you should take this into account when talking with lenders.
There are other things that are important to consider before going to meet or reaching out to hard money lenders, however, we consider these to be very important factors in each conversation.
Conclusion
Be prepared to know what your options are before moving forward with any hard money lender. Having a good understanding of all of these factors going into your meeting with a lender will demonstrate that you are thoroughly prepared and can be trusted with their money!